New credit card era begins as consumer protections kick in

Credit CARD Act interest rate protections began Feb. 22

As of Feb. 22, many of the rules of the credit card game have changed. New consumer protections against surprise interest rate hikes, over-limit fees and easy credit for young people have taken effect through the Credit CARD Act of 2009.

Depending on your perspective, the law is a boon for American families who will save perhaps billions by avoiding unnecessary credit card interest payments and fees, or a bust for banks that will lose billions because they'll no longer be so free to impose those charges.

The biggest consumer benefit from the new law: If you have outstanding credit card balances, the interest rates on those amounts are protected from "any time, any reason" rate hikes. Cardholders and consumer groups complained the most about this long-standing card industry practice because interest rate hikes could be applied retroactively to purchases made earlier.

The cost of a $25 shirt purchased in 2005, for example, could balloon by virtue of an increased interest rate on a revolving account balance. The CARD Act does away with that practice.

Instead, with a few exceptions, card companies can increase rates only on future purchases with the card and only if they give consumers 45 days' warning of the rate hike and the opportunity to decline changes if they chose.

"It is a fundamental change in how credit card companies have to deal with consumers," says Kenneth J. Clayton, senior vice president and general counsel for card policy for the American Bankers Association trade group. "It's a new era in credit cards."

For years, banking industry lobbying groups fought passage of any credit card reform legislation or other financial reform measures. But in recent months, the ABA has done an about-face and begun to embrace the new rules and promote the benefits the law will have for consumers.

The law will make having and using a credit card more predictable and will give consumers more control, Clayton says: "Are their interest rates going to change on existing balances? Are they going to be surprised by some fee somewhere? No longer will they be surprised."

"If you go out and make a purchase, the interest rate on that purchase will not change going forward," says Nessa Feddis, vice president and senior counsel for the bankers group.

New law no cure-all
Is the reform law a panacea for all that ails the credit card industry? Not a chance. Although some had pushed for its inclusion, there is no national cap on how high credit card interest rates can go. Card companies are adding new products that aren't specifically banned by the new law but raise questions about fairness.

It's a fundamental change in how credit card companies have to deal with customers.

-- Kenneth J. Clayton
American Bankers Association

In fact, consumer groups have sounded the alarm about questionable new fees and practices that are already springing up. A
Citi card that offers a reduced interest rate if the cardholder pays on time, but allows the company to raise that rate without notice if a payment is late by as little as one day has caught the attention of at least two consumer groups for circumventing the intent of the CARD Act.

"The companies have figured out a whole different set of tactics to keep gouging consumers," says Chi Chi Wu, staff attorney at the National Consumer Law Center, a nonprofit legal assistance group based in Boston. The law center and other consumer groups say the new credit card terms and products are further justification for creating a consumer financial protection agency -- a proposal that's part of the massive Wall Street reform package that has stalled in the U.S. Senate.

Adds Pam Banks, policy counsel for Consumers Union: "Consumers still need to be on the lookout for unfair practices, but this new law is a big step forward."

U.S. Sen. Christopher Dodd, chairman of the Senate Banking Committee, urged consumers to watch their credit card statements and mail for changes that are coming with the new law. "Make sure credit card companies are giving you 45 days' notice if they're going to change your terms. If you don't like the new terms, shop around for a better deal and exercise your new right to opt out of the changes," Dodd said in a statement.

The reform law, signed by President Obama in May 2009, is being phased in over a yearlong period. The first phase kicked in Aug. 20, 2009, when consumers began receiving at least 45 days' advance notice of changes to their accounts and gained the right to opt out of significant changes. They were also guaranteed at least 21 days to pay their monthly credit card bills.

What went into effect on Feb. 22The second phase of the law, which started Feb. 22, contains the bulk of the consumer protections. Among other things, the new law will:

Restrict issuing and marketing credit cards to people under 21. If you're under 21 and want a credit card in your own name, the law requires you to show proof you can repay the credit card bill yourself or have someone over 21 co-sign on the account. Once-secret credit card contracts between colleges and credit card firms must be made public to show how much colleges are getting when selling student and alumni contact information to credit card marketers. Offers of free pizzas and other goodies as inducements to get students to sign up for credit cards cannot take place within 1,000 feet of campus or campus events.

Ban universal default, a practice of raising interest rates on card accounts based on the user's payment history with another, unrelated creditor. This practice has been widely criticized as unfair by consumer groups. However, the ban applies only to existing card balances. Issuers can still use universal default on future card purchases if they give consumers at least 45 days' advance notice and allow them to opt out if they chose.

Require that payment due dates are the same date each month to help consumers avoid late fees.

Ban over-limit fees unless cardholders agree, in advance, to have over-limit protection on their accounts. If cardholders who haven't opted in for this service attempt to make purchases, but don't have enough available credit on their cards, those transactions may be denied.

Ban double-cycle billing. Finance charges cannot be carried over more than one billing cycle.

Make it easier for those who get into trouble with credit to get help. All monthly statements must now contain a toll-free number consumers can call to get contact information for at least three nonprofit credit counseling agencies. Statements must also warn consumers of the dangers of making only minimum monthly payments -- namely, that it will take longer to repay their debts and cost them more in interest.

Require fair allocation of payments. When cardholders have multiple types of balances with different interest rates, credit card issuers must apply monthly payments in a way that minimizes the amount of interest consumers pay.

Limit upfront fees on accounts to just 25 percent of the credit limit during the first year. This will prevent so-called "fee harvesting" credit cards from using too much of the available credit on the card. Consumers have complained that by the time these fees were assessed, they had little credit available on the accounts to actually use the cards to make purchases.

Phase III comes August 2010The final phase of the law takes effect Aug. 22, 2010. That's when gift cards cannot expire in less than five years and cannot incur inactivity fees if not used for less than 12 months.

Also, as of that day, card users whose rates were jacked up because they missed payments or paid late may get interest rate reductions if they were good and paid their bills on time for six months. The law says card issuers must review those accounts going back to January 2009 and consider whether to lower the rate. However, it does not require them to do so.

Under the law, fees charged for late payments or exceeding the limit on a credit card must be reasonable and appropriate for the type of mistake.

New disclosure rules comingIn addition to the CARD Act, the Federal Reserve is also implementing new disclosure rules for credit card applications, solicitations and monthly statements. Designed to make those legal-type credit card agreements and monthly statements more consumer-friendly, the changes include requiring important account terms -- such as interest rates, fees, triggers for penalties and due dates -- to be displayed in large type in table format for easy reading. Those rules take effect July 1, 2010.

Impact on industryCard industry analysts say, over time, the impact of the credit card reform law will likely be higher credit card interest rates and more fees. Banks will be hit by lost revenues because of the new restrictions on interest rate hikes for existing card balances. One industry analyst, R.K. Hammer Investment Bankers, estimates as much as $50 billion in lost income from interest paid by consumers over the next five years. Hammer notes that some of the lost income will be offset by new fees many credit card companies are initiating and from lower charge-offs as the economy continues to recover and more people go back to work.

The unintended negative consequences of these laws will last years.

-- Robert Hammer
Card industry consultant

On the flip side, the Safe Credit Cards Project estimates the new law will save consumers at least $10 billion a year from just two of the provisions -- the ban on retroactive interest rate hikes and the end of "hair-trigger" penalty rate increases.

Elizabeth Robertson, director of payments research for the Javelin Strategy card consulting firm, predicts credit card issuers won't continue to falter. The credit tightening seen over the past year will begin to loosen beginning in 2011, Robertson says.

"As the economy begins to recover, there will be some shift back to credit," she says, adding "certainly the use of credit will recover." The growing emphasis by many families on saving more and using debit cards rather than credit cards will have a lasting effect, she says, and the amount of borrowing on credit won't likely grow to the nearly $1 trillion level seen before the economic meltdown. "We don't expect it to rebound to earlier levels, but it will not continue to decline."

Robertson says credit card offers will pick up, but they will be directed toward people with stronger credit scores. People with bad credit will face hard times, however. "There will be some part of the market that's actively seeking credit, but will have difficulty."

In the months leading up to Feb. 22, credit card issuers sent out millions of letters to customers notifying them of a slew of changes: flipping many from fixed rate to variable rate cards, hiking interest rates and fees, introducing new fees, closing accounts and slashing credit limits. Some of that was directly linked to manuevering before the CARD law restrictions kicked in, but Clayton from the banking group says it was also driven by the economy.

Still, some, such as Hammer consulting firm CEO Robert Hammer, express alarm about what the law has wrought.

"Make no mistake, there are some very good, needed changes that the well-intentioned laws bring to the table, like better disclosure, simpler terms and restrictions of how fast rate increases can occur," says Hammer. "But the general sweeping impact of all the new legislation is so far reaching and of such deep significance that it simply takes one's breath away. The unintended negative consequences of these laws will last years."

His sentiments were echoed by the American Institute for Economic Research, a Massachusetts independent economic research group. "Borrowers with solid credit and a history of paying off their credit card charges on time will be treated exactly the same as those with poor credit and a history of late payments under the new law," Polina Vlasenko, an institute researcher, wrote in a statement.

Clayton and Feddis, from the bankers group, say the law's interest rate restrictions will translate into higher credit costs for all credit card users.

"You'll see a tick up in interest rates," Clayton says. "There's no doubt about that. You will see less access to credit cards to those who have blemishes on their credit records. For those people, you have to either start them off with higher rates or lower balances or both -- or not give them a card at all."

"Everybody pays a little bit more in the event that one in the group doesn't pay," Feddis says.

Clayton acknowledged that credit card issuers failed to rein in bad practices by policing themselves. Some say much of the public and congressional outcry about unfair practices may have been diffused if banks had changed their ways. "We could have done a better job disclosing the terms of the accounts," Clayton says. "I hope that issue is in the past based on what's coming up. We could have done a better job and we will be doing a better job."

Published: February 22, 2010

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